Ah, day trading, the ultimate signal of feel-good in the markets 1. It’s the harbinger of doom, because it is a signal of irrational exuberance. A bunch of day-traders were on the telly a few days ago, hat-tip to Under The Money Tree who flagged up Traders – Millions by the Minute as an object-lesson in what not to do.

There are two fundamental approaches to trying to make money out of the stock market. One is to regard it a way of purchasing a selection of productive assets, and then becoming a rentier, sitting back and taking a slice of those productive assets without having to do any work. Don’t knock it -that’s the way the super-rich are getting richer. They’re not saving from income, that’s soooo 20th century, dahlink. You need to have inherited wealth or stupendous good luck. The latter is how Russian oligarchs get rich, the former is how Paris Hilton and the Ecclestone daughters got rich. You don’t get to have a pad at the Odeon Tower Monaco if you’re on the side of income no matter how clever you are or how good a footballer.

Capital, not income will get you here

Half a billion is doable as income, but you need a turbo-charge from the stock market to keep you there. CEOs and the like have managed to get into this area by getting on the side of the stock market, but they don’t day-trade.

The second is to regard the stock market as a casino, and to attempt to pick a smidgen of signal from the noise the market throws off. In Traders-Millions by the Minute the punters were taking this line, using spread-betting. The Ermine has indeed had dealings with spread-betting. I’m a fan of it in dealing with sharesave, because you can lock-in profits. Though I lost money on that side of the trade I achieved my goals. Every year I get on the wrong side of the trade with my house insurance too, and lose money. I am cool with that.

WTF? The Ermine is a fan of trading and spread-betting?

Sometimes you have to hold shares for a particular period. Sharesave and Employee Share Incentive Plans are a classic case, particularly the latter. You have to be a special kind of mug to lose money on Sharesave, but on ESIP you can, because you purchase the shares from pre-tax income but have to hold the shares for five years from purchase, else you get to pay the tax and NI you didn’t pay to buy the shares.

So say you buy 100 shares of Megacorp at £1 a share using £60 of your hard-earned cash post-tax. The £100 only costs you £60 because the taxman doesn’t thieve £40 from your income in this instance. But you have to hold those shares for 5 years. If they go down to 60p at the end of those 5 years you break even, less five years of inflation.

If you short the number of shares you buy, then you will cancel out any gain or loss on the shares, though it will cost you something to do that. But you do get the benefit of the 66% tax bung. Why 66%? Because you forgo £60, but you get £100. Thus a profit of 40/60 or 2/3 = 66%/ Less three years of inflation, say about £10, so you come down to 50% up.

I used this towards the end of my time at work with ESIP and Sharesave – to protect myself against significant falls in The Firm’s share price. As it was The Firm’s SP went up, and I got to pay IG about £1000. I was easy with that – it was worth paying to insure myself against losing a lot of what I had gained already.

Social Trading and Trading Superstars, a new development in the trading universe

Apparently you can now track some other trader’s trades if you can’t be bothered to do the legwork yourself. It really puzzles me whyit’s not obvious what’s wrong with this. The long-term rise in the stock market is roughly 5% p.a. real 2 , though you have to be invested for long periods of time (about 20 years) for things to settle out like this. It’s one of the reasons why I believe index-investing’s studious ignorance of high CAPE/valuations is am issue. But that’s something for another day. So traders, every day, are exposed to 1/7300th of their stake on average in real stock appreciation if they go long, less the cost of the spread on every turn which applies going long or short.

Now trading tends to be a short-term activity – that daily gain from the stock market going long isn’t going to speak for much there at 0.01% per day. So you profits as a trader have got to come from somewhere, and it comes from either the punters or the casino your spreadbetting firm. Seen any spreadbetting firms go bust recently? Nope. So it’s coming from the punters. In theory it could come from the markets, because the SB firm presumably hedges any major shifts building up over time, but the programme seemed to indicate most of the profits were from the spreads on the trading, which stays within the system.

And therein lies the rub. If all the punters start getting ahead, the odds will lengthen. Particularly in spreadbetting, where you are running on a model of the real thing, not the underlying market.

The trick with day-trading is to quit when you’re ahead

Over a dreary telephone conference at work way back in 2010/11 an Ermine extracted £400 from IG index on gold, trading per tick, and gave up £350 of it by the end of the meeting. It was sheer luck. Some while later I dabbled in forex trading, using a VAR spreadsheet to control risk. After a few months 3 I looked at the results, observed how much risk it was necessary to pay the fees. I experimented with IG’s automated trading system, where you try and craft a black-box strategy based on the previous charts price history, and back-test it on historical data without using real money.

I could find no strategy that permitted risk to stay bounded as time passed – everything seemed to trend towards a martingale situation where you can always win – if you have infinite wealth and infinite time. If you have infinite reserves of wealth you don’t need to piss about with spreadbetting, cos you don’t have infinite time. I was never tempted by the breathless folks offering courses and training to learn how to trade xyz because of the natural suspicion – if you can make me rich then why the hell aren’t you in some darkened room making yourself rich, dude? Cut out the middleman. I guess it’s the gonzo version of the active fund charges.

I was Frankie, although I derived the result in a different way from The Escape Artist, by observation and hypothetical experimentation. So I took my £800 gains plus the £1000 stake, and stopped doing that, because it was the logical thing to do. MMM has a nice post on get rich with science. It’s harsh, but when you see the statistics tell you that this is more luck than judgement you can either ignore the results or take the insight offered. If I want to make money out of a spread-betting firm, I will buy their shares. I did learn from this, however, and applied the knowledge to my investing. Trading costs you money. So I stopped selling, and made it a priority to sit on my backside and take the dividends.

That, fundamentally, is the trouble with day-trading. In the end you are part of generating the wall of noise – for you to gain, somebody else must lose. This does not necessarily hold with the stock market over the years – because in aggregate returns accrue to capital. But those returns accrue very slowly. To actually get rich from a 5% p.a. real return you need to live frugally and ideally you need to take a multi-generational view. If you have talent and/or cunning, you are much better off leveraging your capital with a business and then selling it.

How do the rich get rich?

Take a look at the top 10 of the Forbes Rich List There are more Mark Zuckerbergs, Bill Gates et al than there are Warren Buffets. If you look through the top 10, the sources of wealth are typically from running or selling a business, followed by ancestral wealth of some sort. Four are self-made, and six are inherited wealth. Forbes trumpets this as saying the American Dream is hale and hearty. I’m not quite sure I want to imagine what it looks like when it’s poorly – holders of old money outweighing new in the top 10 shows maybe the rags to riches isn’t quite as easy as it’s made out. But it can be done. Something else of note is: no actors/actresses. No musicians. No sportspeople. None of the ways teenagers hope to get rich. Something else of note is that most of these are no spring chickens – it’s the greybeards who have all the money. And they’re not a pretty bunch, eh, indeed some of them probably can’t have intact mirrors in their homes.

Of those ten, only one ‘made it on the stock market’. And curiously few in the top 25 ‘made it day-trading’ 😉 Mind you, Sheldon Adelson comes in at #12 from running casinos. There’s nothing wrong with casinos as a way of making money. It’s just that most people go the wrong way about it! Don’t walk through the casino doors. Own them.

Notes:

I wrote the first draft at the end of September. The feel-good doesn’t quite ring true now – exciting times ahead? ↩